Exercise caution with cash rent agreements

"Leases that allow rents to adjust or cash leases with short lease periods are appropriate in times of price uncertainty," says Gary Schnitkey, who with colleague Dale Lattz has prepared a new report on the subject. "Moreover, long-run increases in commodity prices do not automatically translate into farmers having long-run higher returns or risk reductions."

Verbal reports indicate that 2007 cash rents on some land tracts are increasing over 2006 levels. Portions of these increases likely result from projections of higher commodity prices, Schnitkey notes.

"While futures contracts do suggest higher prices, there is considerable uncertainty whether the high prices actually will occur and whether they are sustainable," he says.

The report discusses historical precedents for the current situation. Both corn and soybean prices increased and reach higher plateaus in the early 1970s but later demonstrated considerable variability. It was prepared using data from the Illinois Farm Business Farm Management (FBFM) Association, which involves 6,000-plus farmers throughout the state.

"Currently, there is a reasonable possibility that corn and soybean prices will be considerably higher than historical averages," Schnitkey says. "Futures prices suggest that cash prices could average $3.20 for corn and $6.90 for soybeans over the next several years. Much of this increase is attributed to increased demand for corn in ethanol production.

"Good arguments can be made that biofuel uses may result in permanently higher prices, similar to the situation in the early 1970s. Conversely, it is also possible that crop production increases or reduced demands could result in commodity prices nearer historical levels."

Before the prospects of ethanol production caused an increase in expected prices, profitability of crop production in 2006 and 2007 was expected to be near average to slightly below average due to cost increases.

Schnitkey and Lattz made two recommendations in their study. First, they advise the use of lease arrangements that allow payments to landlords to adjust to returns when warranted. These arrangements allow landowners to share in higher returns if higher commodity prices actually occur in the next several years.

"If higher prices do not occur, payments to landowners are maintained at manageable levels," says Schnitkey. "Lease arrangements in this category include share-rent, share-rent with supplemental payments, and adjustable cash rent leases."

Second, increasing cash rents on the prospect of higher commodity prices should be undertaken with caution.

"If rents are increased as a result of commodity prices, the length of the lease should be kept short, perhaps only a year in length," Schnitkey says. "Higher prices have a reasonable prospect of occurring in 2007. Higher prices in 2008 and beyond are less certain."